Can The Buy-And-Hold Strategy Ruin Your Retirement?

The buy-and-hold investment strategy has become very popular over the years. Buy-and-hold is a passive investment strategy in which an investor buys equities and holds them for a long period of time, regardless of fluctuations in the market. One of the reasons it has become so popular is that people are finding out that trying to time the market by emotional investing doesn’t work very well.

While the stock market was crashing in 2008, many investors could not resist the urge to sell as they watched their life savings sink lower and lower each day.Getty Images

Emotional investing is when investors allow their emotions to dictate when to buy and sell positions. There is an inherent problem with this; we all know that we are supposed to buy low and sell high, but our emotions often tell us to do the exact opposite. For example, while the stock market was crashing in 2008, many investors could not resist the urge to sell as they watched their life savings sink lower and lower each day. Human nature dictates that we want to win, so we often sell when the market is going down, which means we are selling at a low point. This is further substantiated by a recent Investment Company Institute study. As you can see in the graph below, people tend to buy right along with the direction the market is moving when they should be doing the exact opposite, all because they allow their emotions to dictate their investing!

Investment Company Institute

Due to human nature, we tend to buy and sell at the wrong times. This often doesn’t work out well for us, as indicated in the Dalbar study shown below:

DALBAR

If the buy-and-hold strategy is so popular, then how can it possibly be that bad? It has to do with the devastating effect a market crash can have on a person’s portfolio, especially a person who is retired or nearing retirement. Back in 2008, the S&P 500 dropped more than 37%.(1) There was a 17-month period between 2008 and 2009 in which the S&P 500 dropped 50.95%!(2) If investors shouldered that loss and held on to their portfolio, it took several years, on average, to get back to where they were before. If their money was in a 401(k) plan, and they were adding funds to it on a regular basis, it took less time to recoup.

But what if they were retired and withdrawing funds from their portfolio to live on? What if a market crash were to happen to retirees today, and they were drawing 4% from their portfolio to live on each year? What would happen to their income? It would go down, wouldn’t it? What would happen to the cost of living each year? It would go up, wouldn’t it? What would happen to their portfolio? It would go down, wouldn’t it? How long would it take for their portfolio to come back? The truth is, if someone is also drawing income from it, a portfolio may never come back from a major market crash. Is buy-and-hold really the best strategy for a retired or nearly retired person today?

One strategy is showing some rather impressive results. It’s called tactical management, and it is a technologically advanced process based on research and designed to deliver sophisticated portfolio management to investors. The process uses formulas to help mitigate risk through diversification, market trends, economic indicators, and history.

Let me give you an example of how one of these formulas could work. Today, there are over three dozen economic indicators, such as consumer comfort, business confidence, home-price index, chain store sales, etc. Computer software charts where these indicators stand on a day-to-day basis. The software takes a picture of where these indicators stand today and then goes back in history to find periods of time when the indicators were closely aligned with where they are today. Then, it checks to see where each of the markets (stock, bond, real estate, commodities, etc.) trended next in the past. It uses a formula to help it invest the portfolio into the markets that, based on historical activity, are more prone to growth. This tactical management approach seeks to avoid major market crashes and still capture growth in positive times. In the long run, utilizing a tactical approach helps to seek higher returns overall by avoiding catastrophic declines that a buy-and-hold approach could be devastated by.

As noted, this is just one formula. A great portfolio should use multiple formulas to diversify it. Many of these formulas take advantage of trends in the markets, of which there are many (stock, bond, real estate, commodities, foreign equities, etc.). Did you know that, if a market went up in January, again in February, then again in March, it is more likely to go up in April than down?(3) Wouldn’t it make sense to have your portfolio managed in a way that allows it to be continually invested in markets that are trending upward? This gives the tactical management strategy a significant advantage over the buy-and-hold strategy.

It has been my observation that well-diversified, tactically managed portfolios tend to capture good portions of market growth while avoiding major market losses. It is a strategy that would be wise for investors, especially those who are currently retired or approaching retirement, to seriously consider.

Investment Advisory Services offered through Retirement Wealth Advisors (RWA), a Registered Investment Advisor. A Better Way Financial and RWA are not affiliated. Investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision. DT472209-0519

Frank Guida has worked side-by-side with thousands of individuals and families over his career in financial services. He has a true passion for helping others prepare for retirement. Focusing on conservative financial strategies, Frank works with seniors and retirees to find...